A Monopoly’s Marginal Revenue A monopolist’s marginal revenue is always less than the price of its good. The demand curve is downward sloping. When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases. 15 16

A Monopoly’s Marginal Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q). The output effect—more output is sold, so Q is higher. The price effect—price falls, so P is lower. 18 17

Demand and Marginal Revenue Curves for a Monopoly... Price $11 Marginal revenue Demand (average revenue) 10 9 8 7 6 5 4 3 2 1 -1 1 2 3 4 5 6 7 8 Quantity of Water -2 -3 -4 16 22

Profit Maximization of a Monopoly A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. It then uses the demand curve to find the price that will induce consumers to buy that quantity. 19 23

Profit-Maximization for a Monopoly... Costs and Revenue Monopoly price Average total cost A Demand Marginal cost Marginal revenue QMAX Quantity 20 30

Comparing Monopoly and Competition For a competitive firm, price equals marginal cost. P = MR = MC For a monopoly firm, price exceeds marginal cost. P > MR = MC 23 31

Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q A Monopoly’s Profit Profit equals total revenue minus total costs. Profit = TR - TC Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q 40 32

The Monopolist’s Profit... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Monopolist’s Profit... Costs and Revenue Marginal cost Monopoly price E B Monopoly profit QMAX Average total cost Average total cost D C Demand Marginal revenue Quantity 27 39

The Monopolist’s Profit The monopolist will receive economic profits as long as price is greater than average total cost. 23 40

The Market for Drugs... Costs and Revenue Price during patent life Price after patent expires Marginal cost Marginal revenue Demand Monopoly quantity Competitive quantity Quantity

The Welfare Cost of Monopoly In contrast to a competitive firm, the monopoly charges a price above the marginal cost. From the standpoint of consumers, this high price makes monopoly undesirable. However, from the standpoint of the owners of the firm, the high price makes monopoly very desirable. 31 42

The Deadweight Loss Because a monopoly sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost. This wedge causes the quantity sold to fall short of the social optimum. 33 47

The Inefficiency of Monopoly...compared to PC Price Deadweight loss Marginal cost Monopoly price Monopoly quantity Efficient quantity Marginal revenue Demand Quantity 34 53

In perfect competition, the D curve embodies the MR curve which means the monopolists’ quantity is lower and their price is higher

The Inefficiency of Monopoly The monopolist produces less than the socially efficient quantity of output.

The Deadweight Loss The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax. The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit.

Public Policy Toward Monopolies Government responds to the problem of monopoly in one of four ways. Making monopolized industries more competitive. Regulating the behavior of monopolies. Turning some private monopolies into public enterprises. Doing nothing at all. 39 54

Increasing Competition with Antitrust Laws Antitrust laws are a collection of statutes aimed at curbing monopoly power. Antitrust laws give government various ways to promote competition. They allow government to prevent mergers. They allow government to break up companies. They prevent companies from performing activities which make markets less competitive. 39 55

Two Important Antitrust Laws Sherman Antitrust Act (1890) Reduced the market power of the large and powerful “trusts” of that time period. Clayton Act (1914) Strengthened the government’s powers and authorized private lawsuits against corporations.

Regulation Government may regulate the prices that the monopoly charges. The allocation of resources will be efficient if price is set to equal marginal cost. 39 56

Marginal-Cost Pricing for a Natural Monopoly... Price Average total cost Loss Average total cost Regulated price Marginal cost Demand Quantity 63

Public Ownership Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself. (e.g. in the U.S., the government runs the Postal Service until the 1980s). 39 64

Doing Nothing Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies. 39 65

Price Discrimination Price discrimination is the practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same. 41 68

Price Discrimination Price discrimination is not possible when a good is sold in a competitive market since there are many firms all selling at the market price. In order to price discriminate, the firm must have some market power (monopoly, oligopoly, monopolistic competition) 41 68

Perfect Price Discrimination Perfect price discrimination refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price. 41 68

Price Discrimination Two important effects of price discrimination: It can increase the monopolist’s profits. It can reduce deadweight loss* 41 69

Welfare Without Price Discrimination... (a) Monopolist with Single Price Price Consumer surplus Deadweight loss Monopoly price Profit Quantity sold Marginal cost Marginal revenue Demand Quantity 41 72

Welfare With Price Discrimination... (b) Monopolist with Perfect Price Discrimination (Price will vary with quantity) Price Profit Marginal cost Quantity sold Demand Quantity 41 73

Examples of Price Discrimination Movie tickets Airline prices Discount coupons Financial aid Quantity discounts Amazon 42 74

The Prevalence of Monopoly How prevalent are the problems of monopolies? Monopolies are common. Most firms have some control over their prices because of differentiated products. Firms with substantial monopoly power are rare. Few goods are truly unique. 44 77